Cyprus and the Bigger Picture

Should foreign investors and businesses be asked to partially fund a bailout deal of the country that they are holding money and/or operating their business in?

What happens to bank deposits in Europe if the Cypriot government goes through with a plan to implement a one-time levy on banking deposits in the country?

These are some of the questions that are being asked after it was revealed this weekend that a 10 billion Euro bailout deal for Cyprus will likely include a "tax" on all of the banking deposits in the country.

According to various sources, the "troika" (International Monetary Fund, European Commission and European Central Bank) have demanded the implementation of the deposit levy. The actual levy is still being debated, but the latest numbers have it looking something like this:

There is an estimated $68 billion in deposits in Cypriot banks, with approximately 37% belonging to foreigners. According to reports, Russian investors and businesses have an estimated 20-35 billion Euros in deposits at Cypriot banks. As you can imagine, the Russian government is not too happy with the proposed levy, with Putin reportedly calling it "unfair, unprofessional and dangerous."

Banks in Cyprus are currently closed until their parliament and the "troika" agree to a final deal. This is obviously being done to prevent a massive bank run - some residents of Cyprus are so furious with what is being proposed that they are attempting to physically break into the banks in the country.

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This news caught everybody pretty much completely by surprise.

One of the most surprising elements of the proposal is the fact that "small" deposits would be included in the levy as well, though they would take a smaller hit compared to larger deposits. It was widely assumed that people with less than 100k Euros would be excluded from any type of deposit levy, but this is not the case. (Note: the original proposal had deposits of less than 100k being hit with a 6.75% levy, but it's likely that this will be adjusted lower after a massive public outcry).

Another interesting thing to note is the fact that deposits in Cyprus were insured up to 100k Euros, but this won't prevent a percentage of the deposits from being confiscated.

This move also calls into question the "sanctity of bank deposits in Europe", as Pimco Co-CIO Mohamed El-Erian put it. Will future bailout deals in Europe contain the same type of "bank deposit levy" provision? Will people look to pull their money out of European banks en masse?

One final question - what will happen to the Cypriot banking system if foreigners (especially Russians) pull all of their money out of the country after this bank deposit levy goes through?

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This is a very interesting development that has far-reaching implications for the European Union and the rest of the world.